by Richard B. Robinson *
IRC Section 1411 imposes a new Medicare tax on the net investment income of individual taxpayers. The tax is equal to 3.8 percent of the lesser of:
An S corporation is not subject to the new Medicare tax, but each individual shareholder will compute his, her or its tax liability under IRC Section 1411 by taking into account his, her, or its share of the corporation's investment income and related deductions. The tax is also applicable to estates and trusts. Therefore, an estate or trust that is an eligible shareholder and subject to the tax will be required to take into account its share of the corporation's investment income and related deductions for purposes of computing the tax. The tax is effective for tax years beginning after December 31, 2012. [Health Care and Education Reconciliation Act of 2010, Pub L No 111-152, Pub L No 111-152]. The tax does not apply to a nonresident alien or a charitable trust. [IRC Section 1411(e)].
Net Investment Income
A taxpayer's net investment income is the excess of: (1) the gross income from interest, dividends, annuities, royalties, rents and other income from a passive activity (within the meaning of IRC Section 469) and net gains from the sale of property which is not active income (within the meaning of IRC Section 469); over (2) the deductions properly allocable to such gross income or net gain. [IRC Section 1411(c)(1) and (2)].
Regulations are needed to identify what deductions are properly allocable to investment income. Obviously, expenses incurred to produce the investment income should be included. If the investment income is also subject to the built-in gains tax, IRC Section 1366(f) permits a shareholder deduction for the amount of the tax paid by the S corporation. It is not clear whether this deduction would be deemed to be properly allocable to the related built-in income or gain...
Modified Adjusted Gross Income
Modified adjusted gross income ("MAGI") is the amount that is compared to the threshold amount for purposes of determining whether or not a taxpayer is subject to the 3.8 percent tax. It is the taxpayer's adjusted gross income (the amount shown on Form 1040, Line 37) increased by the net foreign earned income exclusion (i.e., the foreign income excluded from gross income less certain related deduction exclusions). [IRC Section 1411(d)(1) and (2)]...
The threshold amount is $250,000 in the case of married taxpayers filing jointly, $125,000 in the case of married taxpayers filing separately, and $200,000 for all other individual taxpayers. [IRC Section 1411(b)(1), (2) and (3)]...
Applicable to Estates and Trusts
The Medicare tax applies to estates and trusts as well as individuals. [IRC Section 1411(a)(2)].The 3.8 percent tax is imposed on the lesser of:
Special Considerations for S Corporation Trusts
The S corporation eligibility rules restrict stock ownership to certain types of trusts. [IRC Section 1361(c)(2)]...
Grantor trusts are eligible S shareholders. [IRC Section 1361(c)(2)(A)(i)]... Therefore, the deemed owner of the grantor trust, and not the trust itself, is subject to the Medicare tax with respect to any net investment income allocated to the trust from an S corporation.
Qualified Subchapter S Trusts
... [T]he QSST beneficiary, and not the QSST, will be subject to the Medicare tax for any net investment income shown on the trust's K-1. Note, however, that a sale of S corporation stock by a QSST will result in the trust, not the beneficiary, being subject to the tax on the sale. [Treas. Reg. 1.1361-1(j)(8)]...
... Testamentary trusts are subject to the normal tax rules for trusts and may be subject to the Medicare tax on any undistributed net investment income reported by the trust.
Electing Small Business Trusts
An electing small business trust is an eligible S shareholder. [IRC Section 1361(c)(2)(A)(v) and IRC Section 1361(e)].... Regulations will need to clarify whether the normal IRC Section 1(e) highest rate bracket or the modification of the IRC Section 1(e) brackets for ESBTs applies for purposes of computing the Medicare tax for electing small business trusts under IRC Section 1411.
* Richard B. Robinson is a shareholder in the law firm of Lentz, Evans and King P.C. in Denver, Colorado. He earned his J.D. at the University of Denver and his LL.M. in Taxation at New York University. He is an Adjunct Professor in the Graduate Tax Program at the University of Denver. Additionally, he has lectured for CPE programs around the country. His articles have appeared in The Journal of Taxation, Estate Planning, The Colorado Lawyer, Taxes-The Tax Magazine, The Practical Accountant, and The Journal of Taxation of S Corporations. He is co-author of Tax Planning for S Corporations, Second Edition (Matthew Bender); How to Do Tax Planning for S Corporations, published by Matthew Bender as part of its Accountant's Workbook Series; and Federal Income Taxation of Corporations, Sixth Edition, published by The American Law Institute, American Bar Association, and Committee on Continuing Professional Education.Information referenced herein is provided for educational purposes only. For legal advice applicable to the facts of your particular situation, you should obtain the services of a qualified attorney licensed to practice law in your state.
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